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French Connection awaits the right connection

The iconic high-street retailer has returned to profitability for the first time in seven years
March 19, 2019

French Connection (FCCN:41p), a constituent of my market-beating 2016 Bargain Shares Portfolio, has delivered the return to profitability I had predicated my original recommendation on, albeit progress has been painfully slow and the underlying operating profit of £100,000 reported for the year to the end of January 2019 is still modest.

Nevertheless, it has arrived at the right time. That’s because the company remains in discussions with a number of interested parties who approached it with regards to a corporate transaction including a potential sale of the business. The directors expect the strategic review process to conclude in the first half of 2019.

Clearly, chief executive and chairman Stephen Marks will want a sensible price for the 41.7 per cent stake he holds in the company he founded in 1972. So too will the other three largest shareholders who control 39 per cent of the issue share capital between them. Bearing this in mind, French Connection’s market capitalisation of £41.5m is below its net asset value of £46.2m, or 48p a share, even though the company has net cash of £16.2m.

The rationale for a bidder to pay a premium to book value will be based on its ability to dramatically cut operating losses from French Connection’s retail stores (£10.3m loss on revenue of £58m in the financial year to the end of January 2019), and reduce central overheads of £9.9m, so that it can retain far more of the earnings from its hugely profitable wholesale business (operating profit of £15.2m on revenues of £77m) and its license activities (annual income of £5.8m).

Importantly, Mr Marks told shareholders that “our performance in wholesale remains strong especially in the US with reaction to the new collections being very positive”. Another positive is that the average lease length on its 96 retail stores is only 27 months, enabling any acquirer to exit loss-making shops as and when the leases on them expire, and within a reasonable timeframe. The fact that French Connection recognised a £5.2m onerous lease provision in its latest annual results certainly makes the retail estate a cleaner proposition for acquirers. Moreover, in light of the tough UK retail environment, landlords are now far more flexible than they once were when it comes to negotiating new leases, thus putting French Connection in a strong position to play hard ball. There are a further 195 franchise or licensed stores overseas.

Bargain Shares Portfolio 2016 performance 
Company nameTIDMOpening offer price (p) 05.02.16 Latest bid price (p) 18.03.19Dividends (p)Total return (%)
Bioquell (see note one and article)BQE1255900372.0%
VolvereVLE41910200143.4%
Bowleven (see note two)BLVN18.93512.21560.9%
Gresham HouseGHE312.5492057.4%
Oakley Capital OCI146.519011.2537.4%
Juridica (see note three)JIL36.1143227.4%
Gresham House StrategicGHS79693032.2520.9%
Mind + Machines (see note four)MMX87.502.8%
French ConnectionFCCN45.7410-10.3%
Walker Crips (see note 5)WCW44.9255.59-31.9%
Average return    68.0%
FTSE All-Share Total Return  51807167 41.5%
FTSE AIM All-Share Total Return 7471032 41.4%
Notes:
1. Simon Thompson advised buying Bioquell's shares at 149p in February 2016. Bioquell bought back 50 per cent of shares in issue at 200p each in June 2016 through a tender offer and Simon recommended buying back the shares in the market at 145p to give an average buy-in price of 125p (‘Bargain shares updates’, 22 June 2016). The company was taken over at 590p cash per share in January 2019.
2. Simon Thompson advised banking profits on half your holdings in Bowleven's shares at 33.75p, and running the balance ahead of drilling news at the Etinde prospect in Cameroon in the second quarter of 2018 (‘Hitting pay dirt', 9 Apr 2018). The company subsequently paid out a special dividend of 15p a share on 8 February 2019. The total return reflects this share sale.
3. Simon Thompson advised buying Juridica's shares at 41.2p in February 2016. Juridica subsequently paid out a special dividend of 8p a share in June 2016 and Simon recommended buying shares in the market at 61p using the cash proceeds to take the average buy-in price to 36.1p (‘Brexit winners', 1 Aug 2016). Juridica then paid out a special dividend of 32p a share in September 2016 and total return reflects this distribution. Simon advised selling the holding at 14p ('Taking Q1 profits and running gains', 4 Apr 2017), hence the price quoted in the table.
4. Simon Thompson advised buying Mind + Machines' shares at 8p in February 2016. Mind + Machines subsequently bought back 13.22 per cent of the shares in issue at 13p a share. The total return reflects this capital distribution. Simon advised selling the entire holding at 7.5p which is the exit price stated in the table ('Strategic acquisitions', 9 May 2018).
5. Simon Thompson advised selling Walker Crips' shares on Monday 4 March 2019 at 25p ('Bargain Shares Portfolio updates', 4 Mar 2019).
Source: London Stock Exchange share prices

The bottom line is that although the shares are hovering around my buy-in price of 45.7p in my 2016 Bargain Shares Portfolio, having pulled back from the 65p level when I last suggested running profits (‘Bargain shares: On the M&A beat’, 22 Oct 2018), I can still see French Connection’s business achieving a decent premium to book value in the event of a sale of the company. Indeed, it’s not going to take much in the way of incremental margin improvement to get profits rising on £135m-worth of annual sales now that the business has turned profitable. I would continue to hold onto your shares. Hold.

 

■ Simon Thompson's new book Successful Stock Picking Strategies and his second book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. The books are being sold through no other source and are priced at £16.95 each plus postage and packaging of £2.95, or £3.75 if you purchase both books. Details of the content of both books can be viewed on www.ypdbooks.com.

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